Chinese inflationary pressure risks economic recovery

He says Chinese policy makers will be left "having to slam on the brakes" at the start of the new year if they persist with "flawed" plans to calm inflation.

The latest output and input price balances, in November's purchasing managers surveys, suggest that producer price inflation of more than 10% is on the cards for China early in 2011. That would be more than double the annual rate of 5% seen in October.

It's part of a worrying trend that suggests that inflationary pressures are now stretching beyond food prices and into the core of the economy. Yet the Chinese authorities insist that by controlling lending quotas and containing money growth they will keep inflation in check.

Action needed

The central bank has taken some steps to tighten the money supply, as reported here on Reuters back in October and attempts have been made to gain control of the rising inflation rate.

Interest rates have been raised once already – the first time the Chinese have seen a rate hike in almost three years – and deposit reserves required to be held by the banks have also been raised. The activities of foreign investors and companies in relation to property purchases have also come under scrutiny.

But there are other inflationary factors that remain unchecked. Not least the continued growth in emerging markets and expectations that the Chinese yuan will continue to strengthen. Both of which could further fuel inflation.

Ward says while steps have been taken, it is simply a case of not enough having been done.

He says: "Chinese policy-makers aim to quell inflation by clamping down on credit and money growth via hikes in reserve requirements and lower lending quotas, avoiding a big rise in interest rates.

"The strategy is flawed because any slowdown in monetary expansion is likely to be offset by a pick-up in the velocity of circulation as real interest rates fall deeper into negative territory, encouraging more spending and financial speculation.

"By delaying a significant rate hike, the authorities risk having to slam on the brakes in early 2011, with adverse implications for the economy later next year."